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Technical ReportNREL/TP-6A50-56324December 2012

Contract No. DE-AC36-08GO28308

Opportunities for Synergy

Between Natural Gas and

Renewable Energy in the Electric

Power and Transportation Sectors

April Lee, Owen Zinaman, and Jeffrey LoganNational Renewable Energy Laboratory

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National Renewable Energy Laboratory15013 Denver West ParkwayGolden, CO 80401303-275-3000 www.nrel.gov

The Joint Institute forStrategic Energy Analysis15013 Denver West ParkwayGolden, CO 80401303-275-3000 www.jisea.org

Technical ReportNREL/TP-6A50-56324December 2012

Contract No. DE-AC36-08GO28308

Opportunities for Synergy

Between Natural Gas and

Renewable Energy in the Electric

Power and Transportation Sectors

April Lee, Owen Zinaman, and Jeffrey LoganNational Renewable Energy Laboratory

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AcknowledgmentsThis paper was prepared by April Lee, Owen Zinaman, and Jeffrey Logan, with input andfeedback from many other experts at the National Renewable Energy Laboratory (NREL) and

the Joint Institute for Strategic Energy Analysis (JISEA), as well as stakeholders in the natural

gas, renewable energy, and public sectors. The authors take full responsibility for any errors,oversights, or omissions.

National Renewable Energy Laboratory

Austin Brown

Brian Bush

Karlynn CoryPaul Denholm

Bobi Garrett

John Gonzales

Thomas Jenkin

Kathleen Loa

Trieu MaiMarc Melaina

Margo Melendez

Robin Newmark

Brian Parsons

Mark Ruth

Laura VimmerstedtDavid Warner

Joint Institute for Strategic Energy AnalysisDouglas Arent

Morgan Bazilian

U.S. Department of Energy, Office of Policy and International Affairs

Bryan Mignone

American Council on Renewable Energy

Todd Foley

American Gas Association

Kathryn Clay

Paula GantRichard Meyer

Arushi Sharma

Stanford University & Rocky Mountain Institute

Joel Swisher

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List of AcronymsCAFE Corporate Average Fuel EconomyCAES compressed air energy storageCC combined cycleCNG compressed natural gasCSAPR Cross-State Air Pollution RuleCSP concentrating solar powerCT combustion turbineDME dimethyl etherDSM demand-side managementEIA U.S. Energy Information AdministrationEPA U.S. Environmental Protection AgencyFAC fuel adjustment clauseFCEV fuel cell electric vehicleFERC Federal Energy Regulatory CommissionGDE gallon diesel-equivalent

GHG greenhouse gasGTL gas-to-liquidGW gigawattsIPCC Intergovernmental Panel on Climate ChangeIRP integrated resource planningISO independent system operatorITC investment tax creditLDC local distribution companyLNG liquefied natural gasMATS Mercury and Air Toxics StandardsMISO Midwest Independent System Operator

MMBtu million British thermal unitsMPG miles per gallonNGL natural gas liquidsNGV natural gas vehicleNPC National Petroleum CouncilNSPS New Source Performance StandardsPEV plug-in electric vehiclePGA purchased gas adjustmentPHEV plug-in hybrid electric vehiclePTC production tax creditREC renewable energy certificate

RFS Renewable Fuel StandardRNG renewable natural gasRPS renewable portfolio standardRTO regional transmission operatorTcf trillion cubic feetTRR technically recoverable resourcesTWh terawatt-hoursWTW well-to-wheel

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AbstractUse of both natural gas and renewable energy has grown significantly in recent years. Bothforms of energy have been touted as key elements of a transition to a cleaner and more secureenergy future, but much of the current discourse considers each in isolation or concentrates onthe competitive impacts of one on the other. This paper attempts, instead, to explore potentialsynergies of natural gas and renewable energy in the U.S. electric power and transportationsectors.

Part Iof this paper offers nine platforms for dialogue and partnership between the natural gasand renewable energy industries, including development of hybrid technologies, energy systemintegration studies, analysis of future energy pathways, and joint myth-busters initiatives.

Part IIprovides a brief summary of recent developments in natural gas and renewable energymarkets. It is intended mainly for non-experts in either energy category.

Part III, on the electric power sector, discusses potential complementarities of natural gas and

renewable energy from the perspective of electricity portfolio risk and also presents severalcurrent market design issues that could benefit from collaborative engagement.

Part IV, on the transportation sector, highlights the technical and economic characteristics of anarray of alternative transportation technologies and fuels. Opportunities for natural gas andrenewable energy transportation pathways are discussed, as are certain relevant transportationpolicies.

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Table of Contents1 Initiating Collaborative Engagement .................................................................................................. 1

1.1 Introduction ...................................................................................................................................... 1

1.2 Platforms for Partnership ................................................................................................................. 32 Background ........................................................................................................................................... 5

2.1

History and Recent Developments of Natural Gas .......................................................................... 52.1.1 Natural Gas Consumption in the United States ...................................................................... 5

2.1.2 Recent Developments and Market Effects of Shale Gas ........................................................ 5

2.1.3 Looking Ahead...................................................................................................................... 10

2.2 History and Recent Developments of Renewable Energy ............................................................. 12

2.2.1 Introduction ........................................................................................................................... 12

2.2.2 Renewable Energy Market Activity and Drivers .................................................................. 12

2.2.3 Renewable Energy Costs ...................................................................................................... 143 U.S. Electric Power Sector ................................................................................................................. 16

3.1 Background .................................................................................................................................... 16

3.2 An Optimized Diverse Electricity Portfolio................................................................................... 17

3.2.1 Natural Gas Issues ................................................................................................................. 19

3.2.2 Renewable Energy Issues ..................................................................................................... 21

3.2.3 Temporal Framework ............................................................................................................ 23

3.3 Collaborative Market Re-Design ................................................................................................... 23

3.4 Concluding Remarks ...................................................................................................................... 264 U.S. Transportation Sector ................................................................................................................ 27

4.1 Petroleum Lock-In ......................................................................................................................... 27

4.2 Alternative Transportation Options ............................................................................................... 28

4.2.1 Ethanol .................................................................................................................................. 28

4.2.2 Alternative Blended Fuels ..................................................................................................... 29

4.2.3 Drop-In Biofuels ................................................................................................................... 29

4.2.4 Plug-In Electric and Plug-In Hybrid-Electric Vehicles ........................................................ 29

4.2.5 Hydrogen-Fueled Vehicles ................................................................................................... 30

4.2.6 Natural Gas Vehicles ............................................................................................................ 31

4.3

Relevant Transportation Policies ................................................................................................... 32

4.3.1 Fuel Economy Standards ...................................................................................................... 32

4.3.2 Biofuel Production and Blending Incentives ........................................................................ 32

4.3.3 Battery Electric Vehicle Production Incentives .................................................................... 33

4.3.4 Hydrogen Fuel Cell Vehicle Research Funding and Production Incentives ......................... 33

4.3.5 Natural Gas Vehicles and Infrastructure Incentives.............................................................. 33

4.4Natural Gas Pathways in the Transportation Sector ...................................................................... 33

4.4.1 Direct Use ............................................................................................................................. 33

4.4.2 Indirect Use ........................................................................................................................... 36

4.5

Concluding Remarks ...................................................................................................................... 37

References ................................................................................................................................................. 40

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List of FiguresFigure 1. U.S. primary energy consumption by source and sector, 2011 ........................................6Figure 2. U.S. natural gas production by source, 19902010 ..........................................................6

Figure 3. U.S. monthly natural gas prices, January 1990July 2012 ...............................................7

Figure 4. Comparison of as-published life cycle greenhouse gas emission estimates for electricitygeneration technologies ...........................................................................................................13

Figure 5. Renewable energy as share of total primary energy consumption in 2011 (left) and

growth of renewable energy consumption, 19502011 (right) ................................................14

Figure 6. Range in recent levelized costs of energy for selected commercially availablerenewable energy electricity generating technologies in comparison to recent non-renewable

energy costs ..............................................................................................................................15

Figure 7. Annual U.S. net generation, 2002July 2012 (left), and U.S. renewable energygeneration, 2002July 2012 (right) ..........................................................................................16

Figure 8. Simulated returns for natural gas combined cycle and wind generators using PJM RTO

hourly power price and load data for 19992008 ....................................................................18Figure 9. Illustrative framework for evaluating investment options by risk source, magnitude,

and timescale ............................................................................................................................23Figure 10. Natural gas pathways in the transportation sector ........................................................34

List of TablesTable 1. Matrix of Selected Natural Gas and Renewable Energy Characteristics ...........................2

Table 2. 2010 U.S. Transportation Sector On-Road Fuel Usage (Energy Basis) by Mode ...........27Table 3. Vehicle Prices, Fuel Costs, and Ranges for Four Light Duty Vehicles ...........................30

Table 4. Well-to-Wheels GHG Emissions and Petroleum Use for Various Vehicles and Fuels ...36

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1 Initiating Collaborative Engagement1.1 IntroductionNatural gas and renewable energy have been touted as key elements of a transition to a cleanerand more secure energy future.1Still, the specific roles, values, and merits of natural gas and

renewable energy in relation tolong-term goals of energy security and climate change mitigationhave been, and continue to be, debated.

In the energy security arena, both natural gas and renewable energy are building blocks for arobust domestic energy economy. However, there are currently large, but not insurmountable,barriers to harnessing natural gas and renewable energy to meaningfully reduce our nationalreliance on imported oil for transportation. These include the current state of the petroleum-dependent transportation sector and a lack of clarity and consensus on how many alternativepathways to pursue and which ones are best. Early adopters are testing alternatives and willprovide valuable experience, but full deployment of one or more alternative fuels will requirebroader structural shifts.

Regarding climate change, the Intergovernmental Panel on Climate Change (IPCC) reports thatto avoid the largest negative impacts,global greenhouse gas emissions would need to decline by50%85% from 1990 levels by 2050.2Some have argued that, given the difficulty in meetingthis goal, an exclusive focus on natural gas would distract from and impede progress toward theultimate goal of large-scale deployment of a suite of low-carbon technologies, includingrenewable energy, energy efficiency, nuclear energy, and carbon capture and storage.3Othershave offered roadmaps for how cost-effective deployment of natural gas and low-carbontechnologies to meet emissions targets might occur,4while many more have provided insightfulanalyses and framed relevant issues.5

Much of the current discourse is narrowly focused on either natural gas or renewable energy as

distinctly separate components or concentrates on the competitive impacts of one over the other.This paper attempts, instead, to build upon embryonic efforts6to more closely examine the nexusof natural gas and renewable energy and explore untapped complementarities and potentialsynergies on a number of levels.

Use of natural gas and renewable energy has grown significantly in recent years. The two formsof energy appear complementary in many respects: natural gas electricity generation enjoys lowcapital costs and variable fuel costs, while renewable energy generators have higher capital costsbut generally zero fuel costs, excluding bioenergy (see Table 1 for selected examples). Naturalgas is a key input for corn starch-based ethanol fuel production, and new transportationinfrastructure and technology experiences could enable use of both natural gas and renewable

fuels in vehicles. Both forms of energy support a future orientation toward a built environmentthat utilizes local energy supply and use, including distributed generation and home vehiclefueling.

Despite the complementarities and potential for greater coordinated use, the natural gas andrenewable energy industries have at times viewed each other as direct competitors, especially inthe power sector. As of mid-2012, the primary competitive impact of inexpensive natural gas hasbeen over 300 terawatt-hours (TWh) of fuel switching from coal- to natural gas-fired electricity

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since 2008. If natural gas prices remain below roughly $5/million British thermal units(MMBtu), many developers of renewable electricity projects might be hard pressed to offercompetitive power purchase prices, thus limiting the number of projects deployed. Similarly,natural gasproducers and biofuel producers might compete over water, especially during droughtconditions.7

Table 1. Matrix of Selected Natural Gas and Renewable Energy Characteristics

Natural Gas Power Wind Solar Bioenergy

ResourceDistribution

Relatively diversefor unconventionalsupplies; less so forconventional

Diverse but oftenfar from loadcenters

Diverse but best inSouthwest

Diverse but best inMidwest andSoutheast

Capital Cost Low, stable Moderate, somefluctuation

Relatively high,declining

Moderate-high,stable (earlygeneration biofuels)

Fuel Cost Variable butcurrently low

None None Moderate

Output Dispatchable;

flexible

Variable and

somewhatpredictable

Variable and mostly

predictable

Dispatchable power

and fuel

Carbon Impact Most recent lifecycle assessmentsconclude that bothconventional andunconventional lessthan half that of coal

Very low Very low Depends; cornstarch-based maybe slightly less thangasoline

Environmentaland SocialConcerns

Some opposition tohydraulic fracturing;relatively clean-burning fossil fuel

Some oppositionto siting; nocombustionemissions; lowwater use

Some opposition tositing of largeprojects forecosystem reasons;no combustion

emissions or wateruse for PV

Concern overecosystem impactsfor many biofuels,water use

This paper attempts to identify how the natural gas and renewable energy communities might:

Promote a new systems approach to natural gas and renewable energy technologies

Jointly research mutually beneficial policy and market structure options

Communicate with each other, and jointly to the public, to clarify misconceptions.

The structure of this paper is:

1. Part Ioffers nine platforms for dialogue and partnership between the natural gas andrenewable energy industries, including development of hybrid technologies, energysystem integration studies, analysis of future energy pathways, and joint myth-bustersinitiatives.

2. Part IIprovides a brief summary of recent developments in natural gas and renewableenergy markets. It is intended mainly for non-experts in either energy category.

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3. Part III, on the electric power sector, discusses potential complementarities of naturalgas and renewable energy from the perspective of electricity portfolio risk and alsopresents several current market design issues that could benefit from collaborativeengagement.

4. Part IV, on the transportation sector, highlights the technical and economic

characteristics of an array of alternative transportation technologies and fuels.Opportunities for natural gas and renewable energy transportation pathways arediscussed, as are certain relevant transportation policies.

1.2 Platforms for PartnershipPartnerships between the natural gas and renewable energy industries have not historically beena source of significant dialogue, yet today there are many opportunities for the two industries andother energy stakeholders to jointly develop vibrant and robust hubs of integrated research anddevelopment, information exchange, planning, and policymaking. The first step in reaching thisgoal is laying the groundwork of open dialogue and engagement in all possible arenas withinwhich further collaboration might grow.

Opportunities exist for natural gas and renewable energy technologies to be integrated atmultiple levels, from tightly coupled hybrid technologies to more loosely coupled integratedsystem and market designs. The following are a few ideas for potential platforms from which toinitiate dialogue:

Hybrid technology opportunities.Hybrid technologies can uniquely capture therespective benefits and minimize drawbacks of individual technologies. Examplesinclude hybrid concentrating solar power (CSP) and natural gas-fired power generationsystems; biogas and natural gas co-fired combined cycle gas turbines; natural gas-powered compressed air energy storage (CAES) to store non-peak renewable electricity

generation for peak period usage; and alternative transportation fuel production processesthat can use both biomass and natural gas as feedstocks.

Systems integration.Broader complementarities of natural gas and renewable energytechnologies can be realized through co-optimized system integration. Effective systemintegration studies require the input and deep understanding of all components todetermine ideal system configurations. Additionally, the growing deployment ofinnovative electricity systems utilizing real-time energy pricing, smart grids, demandresponse, energy storage, and other emerging technologies further amplifies the need forever-finer levels of compatibility across system components. Lastly, proactiveengagement on planning for and investing in new infrastructure can significantly improvethe ability of energy systems to handle changing consumption patterns and future

industry trajectories.

Power sector market design.Collaborative development of electricity market structuresand regulations, coordination of daily operations, and joint transmission planning canoptimize the use and abilities of natural gas and renewable energy technologies in lieu ofisolated energy planning that does not maximize potential complementarities of thesediverse technology options.

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Comparative analysis of alternative transportation pathways.Deeper analysis ofalternative transportation pathways is required to answer questions on the idealevolutionary path of the U.S. transportation sector. One immediate question is whethernatural gas vehicles or electric vehicles are a better choice in view of cross-sectoralinterests and public policy goals. Another question might be whether natural gas could

serve as a useful conduit toward a hydrogen-based transportation sector. Enhanced quantitative tools and models.Somewhat overlapping with the topic of

systems integration is the need for current energy reliability and planning models tobetter incorporate cross-sectoral impacts, particularly arising from natural gas. Oneexample is the need for electricity reliability models to accurately reflect riskprobabilities of gas plant outages due to fuel supply constraints.

Public policy goals.More dialogue and analysis is needed to better understand thepotential roles of natural gas and renewable energy in enhancing energy diversity,economic prosperity, and climate change mitigation. Integrated action plans can realizethe opportunities of all options in achieving public policy goals at federal and state levels.

Portfolio approach to research and development (R&D).Renewable energy, energyefficiency, nuclear energy, and carbon capture use and sequestration all presentopportunities to decarbonize the energy sector; however, the options are often pittedagainst each other, particularly when it comes to funding and support. Instead, given theuncertainties surrounding the ability of each to reach expected heights of decarbonizationpotential, a portfolio approach to supporting all for future flexibility might be pursued. Inaddition, a portfolio approach could focus efforts to further develop technologycomplementarities.

Joint myth-busters and frequently asked questions (FAQ) initiative.Natural gas andrenewable energy both experience enduring misinformation and inaccurate portrayals

regarding their respective industries. A significant preparation for further collaborationcould involve a joint initiative to dispel popular myths and inaccurate beliefs about eachindustry and answer the most frequently asked questions that each industry may haveabout the other.

Optimized long-term and cross-sectoral utilization of energy resources. One potentialeffort could be to jointly research and analyze which industry and technology pathwaysrepresent optimal utilization of the countrys diverse energy resources across sectors andtimescales. From this, opportunities for natural gas and renewable energy technologies tosupport the others role may be elucidated and implemented.

The joint efforts of the natural gas and renewable energy industries to engage on these and otherplatforms of dialogue and collaboration in good faith can bring new insights to existing bodies ofknowledge that will help define and frame current and future policy questions. Policymakers andregulators can then use this foundation to craft well-designed and complementary energy policiesand regulations to successfully guide the evolution of the U.S. energy industry along desiredlong-term pathways.

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2 Background2.1 History and Recent Developments of Natural Gas2.1.1 Natural Gas Consumption in the United States

No energy source supplies a more diverse range of sectors and uses than natural gas: heating and

cooking in the residential and commercial sectors; feedstock for manufacturing processes in theindustrial sector; peak, intermediate, and base-load electricity generation in the electric powersector; and fuel to power natural gas pipelines and vehicles in the transportation sector. Incomparison, almost all of the coal consumed in the United States is for electricitygenerationwhile nearly three-quarters of U.S. petroleum consumption is for transportation.8

U.S. natural gas consumption is roughly equally divided across the residential and commercial(32% in 2011), industrial (33%), and electric power sectors (31%) (Figure 1). Within each ofthese sectors, natural gas accounted for a significant portion of energy consumption: in 2011,75% of residential and commercial, 41% of industrial, and 20% of electric power sector energyconsumption.9The only sector currently consuming little natural gas is the transportation sector,

which includes both the use of natural gas to power natural gas pipeline transmission networks aswell as natural gas used as vehicle fuel. Of total natural gas consumed in 2011, 2.8% was usedfor pipeline operations, while 0.1% was used as vehicle fuel.10

2.1.2 Recent Developments and Market Effects of Shale Gas

U.S. natural gas production has traditionally come from conventional oil and gas wells.However, in the 2000s, developments in drilling technology, notably the combined use ofhorizontal drilling and hydraulic fracturing, along with access to private and public minerals,high natural gas prices, and increasingly upward shale gas resource estimates, spurred a wave ofdrilling activity in previously uneconomic shale basins, unlocking an abundant supply ofdomestic natural gas. U.S. Energy Information Administration (EIA) data shows that shale gas

production grew by more than 15-fold from 0.32trillion cubic feet (tcf) in 2000 to nearly 5 tcf in201023% of natural gas production in 2010.11With continued growth, shale gas is nowestimated to provide more than one-third of totalgas production.12Together, shale gas, tight gas,and coalbed methane now account for more than half of total gasproduction (Figure 2). Therapid growth of shale gas production has offset declining production from conventional wellsand helped maintain year-on-year increases in overall gas production.

As a result of the volume and speed of rising shale gas production in recent years, the followingimpacts have occurred:

Lowest natural gas prices in a decade

Widening oil-to-gas price spreads

Widening U.S. gas-to-international gas price spreads

Immediate coal-to-gas switching in the electric power sector

Decreasing net imports of natural gas

Evolving supply estimates.

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Figure 1. U.S. primary energy consumption by source and sector, 201113

Note: For figure notes, see source.

Figure 2. U.S. natural gas production by source, 1990201014

0

5

10

15

20

25

1990 1995 2000 2005 2010

trillioncubicfeet

Shale gas

Tight gas

Lower 48 onshore conventional

Lower 48 offshoreAlaska

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2.1.2.1 Lowest Natural Gas Prices in a Decade

Natural gas wellhead prices are currently at their lowest in more than a decade, averaging below$2/MMBtu in April and May 2012 (Figure 3).15Pricesclimbed throughout the 2000s to amonthly average peak of$10.52/MMBtuain July 200816and a yearly average peak of$7.78/MMbtubfor 2008.17From there, prices fell sharplyto their current lows as shale gas

production began to oversupply markets. A warmer-than-average 20112012 winter also droveprices down by decreasing heating demand.18This decrease was partially offset by increaseddemand fromthe power sector but still resulted in the lowest overall winter natural gas demandin five years.19Correspondingly, natural gas storage levels in underground facilities havebeensubstantiallyhigher so far in 2012 compared to the five-year range over the same months.20Residential and commercial natural gas prices have also dropped, albeit to a lesser extent, fromtheir 2008 peaks.21

Current natural gas prices of $2$4/MMBtu are challenging for shale gas producers,whogenerally require closer to a $5$8/MMBtu range to maintain business operations,22particularlyin dry gasplays. Many have been operating at a loss for some time in hopes that prices will soon

rise again.23

In the meantime, drilling has shifted over to liquids-rich fields in search of moreprofitable oil and natural gas liquids (NGL).24Energy markets continue to equilibrate in responseto changing market dynamics of gas, oil, andNGL supplies and prices. How these dynamics willsettle in the long term and around what prices is uncertain, though EIAs latest forecastanticipates wellhead prices to be in the range of $4.00$5.50/MMBtu for 20202030.25

Figure 3. U.S. monthly natural gas prices, January 1990July 201226

2.1.2.2 Widening Oil-to-Gas Price Spreads

U.S. spot prices for crude oil and natural gas, historically strongly correlated, have become

increasingly decoupled as natural gas prices remain dampened by domestic oversupply and oilprices continue to rise, mostly in line with global markets. This growing price spread has led toincreased interest in gas-for-oil substitution opportunities, particularly in the transportationsector. Natural gas at $4/MMBtu roughly translates to an energy-equivalent price of $23/barrel

aConverted from $10.79/thousand cubic feet (Mcf) using 2010 average heat content of natural gas in the UnitedStates of 1 Mcf = 1.025 MMBtu. (EIA. What are Mcf, Btu, and Therms? How Do I Convert Prices in Mcf to Btusand Therms? Accessed August 29, 2012:http://www.eia.gov/tools/faqs/faq.cfm?id=45&t=7.)bConverted from $7.97/Mcf.

0

5

10

15

20

1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012

$/M

MBtu

Residential

Commercial

Wellhead

http://www.eia.gov/tools/faqs/faq.cfm?id=45&t=7http://www.eia.gov/tools/faqs/faq.cfm?id=45&t=7http://www.eia.gov/tools/faqs/faq.cfm?id=45&t=7http://www.eia.gov/tools/faqs/faq.cfm?id=45&t=7

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of oil.cGiven the low fuel cost, compressed natural gas (CNG) and liquefied natural gas (LNG)vehicles present increasingly competitive alternatives to conventional gasoline vehicles. Indeed,commercial and public sector investments in natural gas vehicle (NGV) fleets are alreadyoccurring. But to achieve wider consumer adoption, significant refueling infrastructureinvestments would be required and consumer concerns, such as vehicle range, would need to be

addressed (see Part IV). Another area of interest lies in converting gas into liquid fuels that canbe used in place of gasoline and diesel. This pathway may skirt infrastructure issues but issubject to a number of financial uncertainties (see Part IV).

2.1.2.3 Widening U.S. Gas-to-International Gas Price Spreads

Natural gas markets across the globe have thus far remained localized due to the expense, andsometimes geopolitical challenges, of transporting gas over long distances, which requiresextensive pipeline networks or costly liquefaction/re-gasification facilities for importing andexporting LNG. Consequently, U.S. natural gas is experiencing a significant price advantageover other international gas supplies, presenting potentially large profit opportunities even afterfactoring in the additional liquefaction and overseas transport costs.27Severalcompanies have

already applied for federal regulatory approval to build LNG export facilities.28

In April 2012,the Federal Energy Regulatory Commission (FERC) gave its first authorizationfor constructionof export capacity of up to 2.6 billion cubic feet per day (bcf/d) at the existing Sabine Pass LNGterminal in Louisiana.dPreliminary analysis of the domestic market effects of exportingsubstantial volumes ofLNG predicts a combination of higher domestic gas prices, increasedproduction, reduced domestic demand, and fuel substitution. The eventual magnitude of theseeffects is highly dependent on the scenario assumptions. 29

2.1.2.4 Immediate Coal-to-Gas Switching in the Electric Power Sector

The largest near-term effect of excess natural gas supplies and low prices has been the rapiddisplacement of coal-generated electricity by natural gas generation. In the 1990s, the

combination of electricity market and natural gas price deregulation, availability of new highlyefficient natural gas combined cycle plant technology, developments in offshore production, andexpectations of a substantial domestic supply increase led to the construction of a large fleet ofnatural gas plants.30Since demand did noteventually grow to expected levels, this fleet ofnatural gas plants has been underutilized.e

,31In 2010, natural gas plants represented 39% of total

c$4/MMBtu x 5.8 MMBtu/barrel of oil based on 2011 U.S. production = $23.20/barrel. (EIA. Crude OilConversion Calculator. Accessed August 29, 2012:http://www.eia.gov/kids/energy.cfm?page=about_energy_conversion_calculator-basics#oilcalc.)dAs of July 2012, seven other proposals for export facilities have been submitted to FERC with total export capacityof 10.65 bcf/d. Four more potential sites have been identified to FERC by project sponsors with total export capacity

of 6.18 bcf/d. If approved and built, these 11 facilities plus the approved Sabine Pass terminal could provide 19.43bcf/d (or approximately 7 tcf/year) of export capacity, equivalent to 30% of total U.S. natural gas production in2011. (FERC.North American LNG Import/Export Terminals, Approved. FERC, 2012. Accessed August 22, 2012:http://www.ferc.gov/industries/gas/indus-act/lng/LNG-approved.pdf.; FERC. North American LNG Import/ExportTerminals, Proposed/Potential. FERC, 2012. Accessed August 22, 2012:http://www.ferc.gov/industries/gas/indus-act/lng/LNG-proposed-potential.pdf.)eNatural gas plants experienced average utilization rates of 30%40% of plant capacity between 1997 and 2008,compared to coal plant utilization rates of around 65%75% over the same period (EIA. Electric Power Annual2008, Table 5.2. Average Capacity Factors by Energy Source, 1997 through 2008. Accessed August 14, 2012:http://205.254.135.7/electricity/annual/archive/03482008.pdf).

http://www.eia.gov/kids/energy.cfm?page=about_energy_conversion_calculator-basics#oilcalchttp://www.eia.gov/kids/energy.cfm?page=about_energy_conversion_calculator-basics#oilcalchttp://www.ferc.gov/industries/gas/indus-act/lng/LNG-approved.pdfhttp://www.ferc.gov/industries/gas/indus-act/lng/LNG-proposed-potential.pdfhttp://www.ferc.gov/industries/gas/indus-act/lng/LNG-proposed-potential.pdfhttp://www.ferc.gov/industries/gas/indus-act/lng/LNG-proposed-potential.pdfhttp://205.254.135.7/electricity/annual/archive/03482008.pdfhttp://205.254.135.7/electricity/annual/archive/03482008.pdfhttp://205.254.135.7/electricity/annual/archive/03482008.pdfhttp://www.ferc.gov/industries/gas/indus-act/lng/LNG-proposed-potential.pdfhttp://www.ferc.gov/industries/gas/indus-act/lng/LNG-proposed-potential.pdfhttp://www.ferc.gov/industries/gas/indus-act/lng/LNG-approved.pdfhttp://www.eia.gov/kids/energy.cfm?page=about_energy_conversion_calculator-basics#oilcalc

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installed capacity but only 24% of total generation. Meanwhile, coal represented 30% of capacityand 45% of generation.32

Because of this spare capacity, the electric power sector has been able to capitalize on the currentabundance of natural gas supply, and low prices, with little need for additional infrastructure orsystem investments.33The switch has been exceptionally dramatic within the past six months,with coal and natural gas plants each supplying 32% of total monthly power generation in April2012.34Further dispatch of natural gas will occur up to the constraints of current natural gaspipeline and electricity transmission networks. Beyond that, new infrastructure and marketstructures, particularly for natural gas supply, will be needed for greater deployment of naturalgas generation (see Part III).35Forthcoming expected environmental regulations from the U.S.Environmental Protection Agency (EPA) on power plant emissionsand scheduled age-basedretirements of coal plants have also driven the coal-to-gas switch; 36however, shale gasproduction has significantly advanced the timeline and reduced the cost of this transition.

2.1.2.5 Decreasing Net Imports of Natural Gas

U.S. net imports of natural gas have fallen to their lowest level in decades as imports declinedand exports rose due to the growing domestic supply. The large majority of U.S. n atural gasimports come by pipeline from Canada (more than 80% for the past two decades),37whileexports go primarily to Canada and Mexico (roughly two-thirds and one-third, respectively).38LNG imports experienced strong growth in the early 2000s but have since subsided to around10% of imports.39LNG exports have stayed virtually the same since the 1970s, representing 5%of exports today;40however, as mentioned previously, there is burgeoning interest in ramping upLNG exports, particularly to Europe and Asia. LNG exports are likely to contribute a growingshare to U.S. natural gas exports. f

2.1.2.6 Evolving Supply Estimates

Estimates of total available gas resources in the United States continue to changemostlyincreasing in recent years but with some instances where resourceestimates were lowered as aresult of uncertainties surrounding unconventional gas resources.gCoupled with a future gasconsumption trajectory that is highly reliant on interdependent sectoral possibilities,approximating the number of years of gas supply that the United States possesses is difficult (seetext box in Section 2.1.3). While a review of historical resource estimates shows a general trendof increasing resources41due to technological improvements, among other reasons, the lack ofconsensus around unconventional gas resources and future consumption adds a significant factorof uncertainty to gas-related planning and decision making, particularly for long-livedinfrastructure. Credible, objective analysis of potential scenarios of supply and demand profileswould help inform ongoing dialogues that grapple with the question of how many years ofnatural gas supply exist.

fEIAs Annual Energy Outlook 2012 predicts that the United States will become a net exporter around 2022.gEIA adjusted their estimate of technically recoverable resources from the Marcellus shale play from 827 tcf in theirAnnual Energy Outlook (AEO) 2011 publication to 482 tcf in the AEO 2012, a 40% decrease, largely as a result ofnew well productivity data and updated U.S. Geological Survey (USGS) assessments.

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Demand

Significant uncertainty also exists on the demand side. It is very likely that U.S. gas demand will change and grow inthe coming years for several reasons, including:

The United States is projected to become a net exporter of natural gas. The growing domestic supply isreducing the need for imports while low domestic prices have prompted interest in exporting substantialvolumes of LNG.

The electric power sectors consumption of natural gas is likely to continue increasing as further coal-to-gas fuel switching occurs and new natural gas plants continue to be built. Greater deployment of natural gas transportation technologies would increase the currently marginal gas

consumption by the transportation sector.

If realized, these consumption possibilities may have considerable effects on future gas demand, with correspondingeffects on the ultimate length of domestic gas supply. Additionally, these possibilities are interdependent on eachother and will have unique impacts on overall gas market dynamics. Simple calculations of resources divided byproduction omit the non-trivial factor of market economics and prices in determining levels of supply and demand.

Conclusion

Clear and accurate estimates of natural gas resources are a vital foundation for policymakers, regulators, andindustry stakeholders to develop successful long-term plans, policies, and investments. Significant uncertaintiesexist on both the supply and demand side. Much of this uncertainty will likely be reduced as unconventional gasproduction matures and industry trajectories crystallize. Until then, prudent risk and uncertainty analysis will helpinform robust decision making.

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2.2 History and Recent Developments of Renewable Energy2.2.1 Introduction

Renewable energy has long held the promise of making significant contributions to the U.S.energy sector, but it has only been over the past five years or so that newer technologies likewind and solar PV have begun to concretely demonstrate some of that potential. Rapid growth in

renewable energy deployment and consumption over the past decade has been achieved by acombination of technological improvements, policy incentives, and periodically high prices forconventional energy sources, although new challenges now face the sector.

2.2.1.1 Characteristics of Renewable Energy

Renewable energy sources are diverse and have different types of benefits and challenges. Wind,solar, and ocean energy are plentiful and carry no fuel costs, although their often-higher capitalcosts can make financing difficult, especially if their energy output is variable or otherwise notdispatchable. Conventional geothermal, biomass, and hydroelectric energy also enjoy no fuelcosts and are dispatchable, although the resource base is more limited and location specific. Mostrenewable energy sources have far fewer greenhouse gas emissions associated with their full life

cycle compared to coal and petroleum (Figure 4) and, because they are often availabledomestically, can help improve aspects of energy security by offsetting reliance on importedfuels.42A growing body of work has been dedicated to understanding the challenges and costs ofincreasing integration of renewable energy into the existing energy infrastructure; these studiesoften conclude that challenges and costs are manageable up to certain levels of renewablepenetration but may require changes in operation to traditional business and regulator practices.43Finally, most types of renewable energy have fewer conventional pollutants than traditionalfossil fuels and generally require less consumable water to operate.44

2.2.2 Renewable Energy Market Activity and Drivers

Hydropower, the largest single source of renewable energy in the United States, has seen

relatively stagnant growth since the 1970s, but wind, biofuels, and solar have grown rapidly overthe past five years. Today, renewable energy exceeds nuclear in the U.S. energy supply(Figure 5).

Wind power and ethanol biofuels began growing rapidly in the early 2000s due to high oil andnatural gas prices, technological advancements, deployment mandates (i.e., renewable portfoliostandards), and fiscal incentives. When fossil fuel prices declined due to the global recession,wind, solar, and other forms of renewable energy continued to see strong growth due toincentives offered in the American Recovery and Reinvestment Act of 2009, traditional taxcredits, and state-based renewable energy standards (also known as renewable portfoliostandards, or RPSs). Some of the Recovery Act incentives have now expired and the future for

renewable energy in general looks more challenging given the low growth in demand forelectricity and potentially reduced tax incentives. In addition, low prices for natural gas can makeit difficult for renewable energy project developers to sign power purchase agreements, oftennecessary for financing, and could force many sources of renewable energy to the sidelines untilnatural gas prices rise.

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Figure 4. Comparison of as-published life cycle greenhouse gas emission estimates for electricitygeneration technologies45

Note: The impacts of the land use changes are excluded from this analysis. Here, natural gas refers only toconventional sources.

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Figure 5. Renewable energy as share of total primary energy consumption in2011 (left) andgrowth of renewable energy consumption, 19502011 (right)

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In the transportation sector, corn-based ethanol has been the fastest growing source of renewableenergy over the past decade. Ethanol production has grown by more than seven-fold to 14 billiongallons in 2011, about 8% of the total U.S. highway vehicle fuel.47Ethanol use has beenpromoted by a combination of mandates and incentives, and nowaccounts for about 2% ofprimary U.S. energy supply. Without further developments in non-corn-based ethanolproduction, continued growth in domestic ethanol supply may be limited; production in 2012 hasalready declined due to the drought affecting many corn-growing regions of the United States.48

In the electric power sector wind has dominated other forms of renewable energy to date in termsof growth in generation and capacity installed. Solar PV, in particular, has been growing veryrapidly even if it has started from a much smaller base. After nearly 2 GWof installed solarcapacity in 2011, the United States could cross the 3 GW level in 2012.49State-level RPSs willcontinue to incent deployment of some renewable energy going forward, although many statesare currently ahead of their deployment schedules and some are even debating scaling back theirtargets.50

2.2.3 Renewable Energy CostsMany sources of renewable energy are still more expensive than non-renewable options,although full economic costs, values, and risks are often not represented in market prices acrossall energy production sectors. Some renewable energy costs are changing rapidly, while othersare relativelystagnant. Over the past two decades, wind turbine costs have fluctuatedconsiderably.51Perhaps morewidely noted, solar PV module costs have declined by a reported75% over thepast four years,52making them increasingly competitive with the cost of averageretail electricity service in different regions of the world. Figure 6 summarizes different levelized

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costs of energy service for renewable and non-renewable energy options. How these pricedynamics change in the future will be influenced by many variables, an increasing number ofwhich may be beyond the direct control of U.S. decision makers.

Figure 6. Range in recent levelized costs of energy for selected commercially available renewable

energy electricity generating technologies in comparison to recent non-renewable energy costs53

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3 U.S. Electric Power Sector3.1 BackgroundThe U.S. electric power sector is currently experiencing unprecedented change due to acombination of low-priced natural gas, stricter forthcoming environmental standards, and rapid

growth of renewable energy. These changes have led to a swift decline in coal- and oil-firedgeneration and corresponding increases in natural gas and renewables (Figure 7). Coal-firedgeneration has declined from roughly 48% of annual net U.S. generation in 2008 toapproximately 35% as of mid-2012.54This is arguably one of the most tumultuous periods ofchange in the power sector since World War II. It remains to be seen whether this shift from coalto natural gas and renewables will continue or reverse itself as natural gas prices fluctuaterelative to coal and incentives for renewable energy expire.

Installed wind capacity in the United States grewby more than five times between 2005 andmid-2012 to approximately 50 gigawatts(GW).55Wind electricity generation grew by more thanseven times over the same time period. 56Solar energy generation grew by more than five times

over the period, with the vast majority ofthat growth coming from solar PV capacity additions.57

However, on an absolute level, wind and solar still represent modest contributionsof totalelectricity generation, representing only 3.5% of total U.S. net generation in 2012.58The fleet ofnatural gas combined cycle plants has operated more regularly over the past few years, largely atthe expense of coal plants, increasing in some independent system operator (ISO) regionsdramatically. The weighted average capacity factor for combined cycle plants operating in thePJM Interconnections service territory, for example, was more than double the level from 2008during the first three months of 2012.59

One important set of dialogues that has accompanied the rise of natural gas has recentlycommenced on better coordinating the natural gas and electricity sectors. FERC is largelyspearheading this effort between ISO/regional transmission operator (RTO) and natural gastransmission companies. The following section of this report explores that, and other powersector dynamics, in more detail.

Figure 7. Annual U.S. net generation, 2002July 2012 (left), and U.S. renewable energy generation,2002July 2012 (right)

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3.2 An Optimized Diverse Electricity PortfolioNatural gas and renewable energy technologies enjoy many complementarities spanningeconomic, technical, environmental, and political considerations. These complementarities arisefrom their similarities, which include improved environmental performance compared to coaland oil and their ability to contribute to a robust U.S. economy, but it is from their dissimilarities

that the biggest opportunities for mutually beneficial collaboration can be found.

For electric power stakeholders with multiple assets under their purview, investment decisionson new electric power projects are based on the evaluation of many factors, including: projectcosts and financing, fuel supply availability, current and projected future market dynamics, localand federal energy policies, environmental regulations, and portfolio diversity. Embedded withineach of these factors are varying types and magnitudes of risk, including: financing interest rates,fuel supply uncertainty and price volatility, and environmental compliance costs. Investments innew generation capacity have historically been made project-by-project on a primarily least-costbasis, which does not adequately incorporate risk as represented by the variance of expectedfuture costs. This has led to the development of sub-optimal regional electricity portfolios with

inefficiently higher levels of risk given portfolio costs.61

Traditional integrated resource planning (IRP) by utilities attempted to incorporate the conceptand benefits of portfolio optimization as well as utilize non-supply resources such as demand-side management (DSM).62However, these strategies still focused primarily on minimizing thecosts of a planned generation mix across a selection of possible future scenarios withoutsufficiently incorporating the economic cost of risks or valuing the minimization of theserisks.k,63A simple example is fuel price volatility. Many IRP models assumed specific future fuelpricesintheir cost calculations, or considered a set of possible future prices, but did notincorporate the volatility of those prices. Large short-term (daily, weekly, or monthly)fluctuations in fuel prices introduce considerable generation and revenue variability not

conveyed by the use of long-term average costs and revenues (see Figure 8 for an example).These types of portfolio risks were poorly accounted for in IRP models yet have majorconsequences for energy reliability. Today, IRP models have evolved along a variety of paths,particularly with respect to evaluating portfolio risks. Some utilities now employ scenario andsensitivity analysis, stochastic analysis, ora combination of both to better incorporate portfoliorisk assessment into the planning process. l

Risk minimization is as important as cost minimization. Multiple benefits accrue fromdeveloping markets and policies conducive to building optimized portfolios with efficient levelsof both risk and cost. More robust methods of portfolio evaluation and planning that incorporateexplicit valuation of risks, such as mean-variance portfolio techniques, can help stakeholders

kFor an overview of state IRP programs, see Wilson, R.; Peterson, P. (2011). A Brief Survey of State IntegratedResource Planning Rules and Requirements. Prepared for the American Clean Skies Foundation. Cambridge, MA:Synapse Energy Economics, Inc.lFor a comparison of selected utilities IRP practices and approaches to risk assessment, see Aspen EnvironmentalGroup and Energy and Environmental Economics, Inc. (2008) Survey of Utility ResourcePlanning and Procurement Practices for Application to Long-Term Procurement Planning in California -DRAFT. Prepared for the California Public Utilities Commission.

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3.2.1 Natural Gas Issues

3.2.1.1 Fuel Supply and Transportation

Issue:Domestic natural gas supply is on the rise due to shale gas; total supply estimates continueto be refined as the shale gas experience continues to unfold. Long-term fuel availability willgreatly affect the profitability of new natural gas plants in the latter years of their service period.

Growing natural gas consumption by the electric power and other sectors increases thechallenges associated with gas pipeline constraints,which can cause market-based price spikes65and necessitate investments in new infrastructure.66Additionally, the ability of current pipelinesystems to handle changing gas consumption patterns in the power sectorfrom generally lowutilization rates and sporadic peak demands to overall much higher and continuous utilizationratesare a source of reliability concern, particularly during peak seasonal demand periods.67Cost allocation approaches to funding new infrastructure and ensuring reliable pipeline service tonatural gas generators are the subject of current dialogue.

Complementarity:Renewable energy generation, such as wind and solar, does not experience the

same market-based fuel supply concerns as natural gas generation. Fuel supply is guaranteedfrom a cost standpoint with no exposure to or dependence on market dynamics. (However, thereis significant resource variability and uncertainty risk.)

3.2.1.2 Fuel Price Volatility and Generating Costs

Issue:Natural gas prices have experienced significant historical volatility since the deregulationof gas prices in the late 1980s. This has been attributed to a number of factors, including higherlevels of short-term purchasing, financial trading activity, large variations in seasonal demand,cross-sectoral demand interactions, and the diversity of market participants.68Gas price volatilitytranslates to significant generating cost variance for natural gas plants.

There is much debate over the future level of gas price volatility, especially given the numerouspotentialities of natural gas across sectors (e.g., export of LNG and use as transportation fuel).While recent near- to mid-term projections indicate a range of $4$8/MMBtu out to 2035(depending on supply and demand as well as economic growth),69price variability addsadditional risk to future costs.

Complementarity:Like cost minimization, long-term cost certainty also has important economicvalue to an electricity portfolio.70Renewable energy technologies, such as wind and solar, havezero fuel costs and relatively fixed generating costs when adequately geographicallydistributed.71Thiscost stability reduces the variance of expected future costs, reducing overallportfolio risks.72,n

3.2.1.3 Renewable Portfolio Standards

Issue:Twenty-nine states and Washington, D.C., currently have mandatory RPS programs inplace, while eight more have voluntary goals. The requirements vary widely but most rise to a

nFor a quantitative analysis of the value of reducing fuel price risk within a resource portfolio, see Bolinger, M.;Wiser, R.; Golove, W. (2002). Quantifying the Value that Wind Power Provides as a Hedge against Volatile NaturalGas Prices. LBNL-50484. Berkeley, CA: Lawrence Berkeley National Laboratory.

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target percentage by 20202030. Some targets are fairly minor but others, like Californias 33%renewables by 2020, represent substantial deployment of renewable energy generation.o

Stakeholders operating within state or utility RPS requirements with predominantly natural gascapacity may find themselves subject to compliance costs if renewable targets cannot be met,particularly if jurisdictions increase or advance their RPS targets down the road, a not unlikelypossibility. Overinvestment in natural gas and underinvestment in renewables now couldpotentially impact future compliance.

Complementarity:Renewable energy projects eligible to meet RPS requirements are not subjectto future cost uncertainty, as with little or no fuel costs and typically long-term power purchaseagreements. Renewable generation may acquire additional revenue streams through the sale ofrenewable energy certificates (RECs) or similar monetization of environmental benefits.

The modularity of some renewable energy technologies (kilowatts to hundreds of megawatts)also provides valuable flexibility to deployment timelines of new capacity and can incrementallyhedge risks from future policy uncertainty.73Natural gas investments, on the other hand, tend to

be in larger increments (e.g., 500 MW andmore) of new capacity.

3.2.1.4 Federal Environmental Regulations

Issue:Within the past three years, a number of EPA emission regulations affecting power plants,including carbon dioxide emission-limiting New Source Performance Standards (NSPS), theCross-State Air Pollution Rule (CSAPR), and the Mercury and Air Toxics Standards (MATS), phave been proposed or finalized. While litigation and judicial review have delayedimplementation and prompted reconsideration of several rules in recent months,qthe broadindustry expectation of these environmental regulations have accelerated the scheduledretirement of aging coal plants74and reinforced the belief that no new coal plants will be built inthe future unless their emissionscan be reduced by carbon capture and sequestration, an as yet

unproven and costly technology.

Todays highly efficient natural gas plant technology easily meets the environmental standardsproposed by these regulations and thus have been the predominant generation replacementchoice. This has provided substantial short-term opportunities to reduce the countrys carbondioxide and other criteria pollutant emissions without additional cost or policies.75However, theemissions reduction benefit of natural gas will eventually plateau as long-term emissionthresholds become increasingly stringent. Tightening emission regulations and the possibility offuture low-carbon policies during the 30+-year lifespan of natural gas plants are an area ofconsiderable uncertainty and, subsequently, additional latter-period profitability risk.

Complementarity:In the near-term, the environmental benefit of both natural gas and renewableenergy compared to the current generation mix provides a common platform from which to

oFor more details on state RPS programs, see the Database of State Incentives for Renewables & Efficiency(www.dsireusa.org).pThe NSPS rules would only apply to new power plants, whereas CSAPR and MATS would apply to both new andexisting power plants.qCSAPR was rejected by the U.S. Court of Appeals for the District of Columbia in August 2012. The prior CleanAir Interstate Rule (CAIR) will remain in place while EPA reviews the courts decision.

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garner support for both options.76In the long-term, renewable energy investments will not besubject to future cost risk of environmental compliance measures and instead may find additionalrevenue streams from their environmental benefits should low-carbon policies be implemented.

3.2.2 Renewable Energy Issues

3.2.2.1 Cost-CompetitivenessIssue:After natural gas, wind has been the second-largest contributor of new capacity, withparticularly strong growth in the past five years.77However, only the most favorable wind sites,coupled with supportive state and federal policies, can compete with natural gas on a purelylevelized cost basis.rLess favorable wind sites, solar, and other renewable energy technologiesremain costlier or selectively competitive until continued learning curve efficiency gains and costreductions are made. Relative inexperience and difficulties with siting and permitting also addcosts. The limited cost-competitiveness of renewable energy technologies in the near-term detersgreater levels of deployment. In addition, the relatively high capital cost of renewable projectscould risk being deemed imprudent by regulators evaluating from a least-cost perspective andinsufficiently valuing the mitigation of long-term operating cost variability.

Complementarity:Natural gas plants have low upfront costs, with fuel costs and associated pricerisks largely passed on to consumers (when deemed prudent by regulators) in well-establishedfuel adjustment clauses (FAC) and purchased gas adjustment (PGA) mechanisms. sLow naturalgas prices lower overall levelized costs of energy and will continue to do so in the short term.

3.2.2.2 Uncertain State and Federal Incentives

Issue:The recent surge in new wind capacity has resulted from a package of supportive policiesand incentives, including the federal production tax credit (PTC), investment tax credit (ITC), theRecovery Acts Section 1603 Treasury grant program, tstate RPS programs, and decreasingtechnology costs.

The PTC, in particular, has been instrumental in driving record year-on-year increases in newwind capacity but is set to expire at the end of this year. The impending expiration has alreadyhad effects on the industry with virtually no new wind turbine orders for delivery in 2013. 78Continued growth of wind capacity and the nascent U.S. wind manufacturing industry willdepend on continued policy support until cost-competiveness is attained. In August 2012, theSenate Finance Committee approved a temporary tax extender package that extends the PTC andITC for one year; however, final congressional action remains to be taken. In the meantime, thiscontinuing policy uncertainty affects the industrys ability to make long-term investments andsecure favorable financing.

rThe levelized cost of energy methodology is a simple and useful tool for comparing various energy options;however, it can be misleading in its inability to incorporate important factors that cannot be easily quantified.sWhile regulatory prudence reviews provide a mechanism to engender responsible fuel supply procurement, they donot completely remove the asymmetry of risk burdens between utilities and consumers that FACs and PGAs create.tFor an outlook of U.S. renewable energy financing in 2012, see Sharif, D.; Grace, A.; Di Capua, M. (2011). TheReturn and Returns of Tax Equity for U.S. Renewable Projects. Commissioned by the Reznick Group. NewYork, NY: Bloomberg New Energy Finance. Additional literature on renewable energy financing can be found athttp://financere.nrel.gov/finance/publications.

http://financere.nrel.gov/finance/publicationshttp://financere.nrel.gov/finance/publicationshttp://financere.nrel.gov/finance/publications

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Several state legislatures have proposed bills to repeal or shrink state RPS programswithin thelast couple years. While these efforts have largely been symbolic with little traction,79futurechallenges to RPS programs could arise and similarly impair renewable energy industrydevelopment.

Complementarity:Given its long history of government supportuand the established state of thefossil-based economy, natural gas plants do not require major new policy or incentive supports toachieve cost-competitiveness. Long-term investments in natural gas plants do not hinge upon thecontinuing renewal of local or federal incentives (however, as discussed above, environmentalpolicies introduce significant policy-related investment risks).

3.2.2.3 Resource Variability and Dispatchability

Issue:While variable renewable generation, such as wind and solar without energy storage, donot incur fuel supply risks in the way that conventional power plants do, they do experiencedynamic resource variability along the minute-to-minute, hour-by-hour, and longer timescales.From the utility and regulator reliability planning perspective, wind and solar only provide low

capacity value, which decreases with increasing penetration on the system.80

This capacity canonly be dispatched within the limits of resource availability.

Complementarity:Natural gas can be dispatched flexibly, which offers more capacity for systemreliability. The quick ramping ability of natural gas generators makes them ideal forcomplementing variable renewable generation. This flexibility may generate additional value asnew ancillary service products are designed to accommodate increasing levels of variablegeneration on the grid (see next section on collaborative market re-design) and new regionalcapacity or other ancillary services markets are developed to meet future reliability needs. Abalanced electricity portfolio of both natural gas and renewable energy assets can adjustgeneration shares based on continuous optimization of resource availability, fuel costs, andemission requirements.

3.2.2.4 Transmission Planning and Costs

Issue:Large investments in transmission will be required to harness areas with the greatestrenewable energy potential, such as the high wind potential central regions of the United States,which are mostly far from load centers. Despite widespread acknowledgment of the general needfor an expanded and more reliable U.S. electricity grid, even without large amounts of variablerenewable energy generation, transmission remains a contentious issue with slow-movingprogress on resolving planning, permitting, and cost allocation concerns.

Complementarity:Notable overlaps between natural gas production regions and high windenergy potential regions suggest the possibility of new transmission projects jointly proposed and

supported by new wind and natural gas projects to be sited close to each other. This pooling ofefforts can accelerate implementation of proposed transmission investments and can also helpensure that new transmission is planned to optimize both natural gas and renewable energyassets.

uDomestic oil and gas industries have received tax incentives since the early 1900s and continue to today. For ahistorical review of U.S. energy tax policies, see Sherlock, M.F. (2011).Energy Tax Policy: Historical Perspectiveson and Current Status of Energy Tax Expenditures. Washington, DC: Congressional Research Service.

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3.2.3 Temporal Framework

Because the occurrence of risks along an investments lifetime varies significantly by issue andtechnology, it is also important to consider these risks within a temporal framework. Figure 9provides a generalized illustrative assessment of the magnitude and timescale of the major issuesdiscussed. A more rigorous quantitative application of this framework in the analysis of specific

power project options could help inform stakeholder investment decisions.

Figure 9. Illustrative framework for evaluating investment options by risk source, magnitude, andtimescale

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3.3 Collaborative Market Re-DesignRapidly changing energy industry paradigms and deeper experience with new technologies haveevoked a need for re-designed market structures and business practices suited to current needs.Much has changed within the last decade to make historical practices maladapted to todays needfor highly flexible operations and expected future growth trajectories.

Shale gas has brought unprecedented changes to the gas industry, prompting increased efforts by

regulators and stakeholders to foster efficient market-based gas operations. In August 2012,FERC hosted five regional conferences on gas-electric coordination to better understand theissues faced by gas and electricity stakeholders and how they might help address these issuesthrough new regulations or recommendations.

The growth of variable renewable energy generation in regional electricity networks has led to aflurry of novel industry and regulatory approaches to handling higher levels of variablegeneration. The experience of these approaches, some successful and some not, and the

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subsequent analyses of their results have brought to light areas of operational and marketinefficiencies. They have also produced a variety of recommended technical, structural, andeconomic solutions to improve the assimilation of variable generation at lowest cost with marketefficiency.v

The section below highlights six major market design issues facing natural gas and renewableenergy electricity generators:

1. Harmonization of day-ahead natural gas and electricity scheduling logistics.Significant misalignments exist in the schedulingand procurement of day-ahead andintra-day natural gas and electricity generation.82In several electricity regions, naturalgas generators need to procure gas supplies before receiving electricity schedules fromelectricity system operators, resulting in excess fuel supply risks. Optimization ofelectricity and gas scheduling timelines can minimize the existing inefficiencies acrossthe two markets and reduce system and operating costs.

2. Flexible natural gas pipeline service options.Pipeline transportation service options

were originally developed to meet the needs of historical gas purchasers, mainly gasutilities [i.e., local distribution companies (LDC)].83These options were not well-suitedto the fluctuating and less predictable supply requirements of gas electricity generators.Gas generators today rely on a mix of firm and interruptible pipeline service, third-partydelivery service, and daily released pipeline capacity from LDCs.84While this patchworkapproach has functioned reasonably well so far, the recent upsurge in gas generation hasexposed greater electricity reliability concerns caused by gas pipeline constraints andrelying on interruptible service.85Incidents of gas curtailments to electricity generators,such as the occurrence in New England in January 2004 due to unusually cold weather,86are evidence of this growing challenge. New pipeline service options, particularly forflexible and short-term firm capacity, and improved rules for more efficient and real-time

pipeline capacity release may be needed to meet gas generators highly dynamic needsand ensure adequate levels of electricity reliability.87Currently, somepipeline operatorsprovide customized service options to meet specific generator needs88; however, the lackof standardization and illiquidity of flexible pipeline services may create inefficienciesand additional costs to procurement of pipeline capacity.

3. Implementation of natural gas pipeline expansion and local gas storage facilities.The growing use of gas for electricity has also created the need for more pipelinecapacity. However, pipeline operators have historically relied on long-term (20-year)fixed supply contracts with gas purchasers to demonstrate project necessity to regulatorsand acquire the revenue certainty needed to finance the large investments required fornew pipelines.89Natural gas electricity generators, who comprise a growing portion of

pipeline demandbut rely on highly dynamic regional electricity marketswto determinewhen and at whatprice they will be dispatched, are unwilling to sign long-term fixedsupply contracts.90In turn, pipeline operators are unable to undertake the pipeline

vFor an in-depth discussion of operational and institutional challenges of integrating high levels of renewableenergy, see Milligan, M.; Ela, E.; Hein, J.; Schneider, T.; Brinkman, G.; Denholm, P. (2012). Exploration of High-

Penetration Renewable Electricity Futures. Vol. 4 of Renewable Electricity Futures Study. NREL/TP-6A20-52409-4. Golden, CO: National Renewable Energy Laboratory.http://www.nrel.gov/analysis/re_futures/wIn areas operated by RTOs and ISOs.

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capacity expansions needed to maintain service reliability. This has largely been theresult of regulatory requirements on cost recovery that were developed for the priorindustry paradigm of LDCs as the primary type of gas customer.91Therefore, newregulatory frameworks and methods of contracting and initiatingpipeline expansionprojects may need to be developed. Additionally, fair and reasonable allocation of

infrastructure expansion costs across pipeline customer groups needs to be determined.92

4. Valuation of flexibility.The economic value of generator flexibility in existing

electricity markets has largely derived from the ability of these generators to meethistorical needs for flexibility, primarily to cover fairly predictable daily load profiles andcontingency events and meet system reliability standards. The ability of existinggenerators to provide the flexibility required by variable renewable generation isinadequately valued by current market structures and products. For example, natural gascombined cycle (CC) and combustion turbine (CT) plants provide varying degrees oframping flexibility to accommodate fluctuations in net load,93and both are more flexiblewith lower cycling costs than coal plants. 94Several arenas inwhich this type of flexibilitycould be more explicitly valued include: ancillary service markets with the creation of a

new category of flexibility reserves,95newly developing regionalcapacity marketswhose aims are to incentivize new capacity to meet future demand,96reliability planningmodels to differentiate the capabilities of existing flexible and inflexibleresources,xandthe ongoing endeavor to accurately value energy storage technologies.97

5. Electricity dispatch timing.Regional electricity markets with hourly dispatch schedulesare unable to utilize lower-cost flexible generators within each hourto meet large butrelatively slow ramping needs arising from fluctuations in variable generation.98Instead,all within-hour ramping is met primarily by expensive regulation reserves, which weremeant to stabilize much smaller rapid fluctuations in generation and frequency. Thisresults in inefficiently higher integration costs. Sub-hourly (5- to 15-minute) economicdispatch has been shown to allow existing lower-cost resources to meet a greater portionof the ramping needs caused by variable generation, minimizing the use of expensiveregulation reserves for that purpose.yRegions that currently use hourly dispatchschedules, such as the Western region z(excluding California) and Southeast region of theUnited States, can improve their abilityto cost-effectively integrate variable generationby moving toward faster dispatch schedules.

xFor example, the flexibility of natural gas capacity compared to coal or nuclear capacity is not reflected in energyreliability models used by the Midwest Independent System Operator (MISO) [Technical Conference onCoordination between Natural Gas and Electricity Markets for the Central Region; August 6, 2012, St. Louis,Missouri. Federal Energy Regulatory Commission (FERC)].

yAnalysis of sub-hourly market data has shown that price signals from sub-hourly electricity markets providegeneration to meet sub-hourly fluctuation at little to no extra cost compared to hourly prices. While sub-hourlyprices may fluctuate greatly, on average the price is very close to the hourly energy price. This analysis suggests thatthis type of load-following generation response can be acquired at little cost using existing resources (Milligan, M.;Kirby, B.; Beuning, S.Potential Reductions in Variability with Alternative Approaches to Balancing AreaCooperation with High Penetrations of Variable Generation. NREL/MP-550-48427. Golden, CO: NationalRenewable Energy Laboratory, 2010; 78 pp.).zFor an analysis of the operational feasibility of integrating 35% wind and solar in the Western region, see NREL.(2012). Western Wind and Solar Integration Study. NREL/SR-550-47434. Work performed by GE Energy,Schenectady, NY. Golden, CO: National Renewable Energy Laboratory.

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6. Balancing electricity generation and load over larger geographic areas.The intra-day, intra-hour variability and uncertainty of variable renewable generation as well asload are reduced when consolidated over larger geographic areas.99This results in smalleroverall fluctuations in demand and supply, which reduces the need for relativelyexpensive operating reserves to smooth these fluctuations. This decreases variable

generation integration and load balancing costs. A variety of physical and virtual methodsof consolidating balancing areas have been analyzed.100Regions with small balancingareas can reduce normal load balancing costs as well asbetter integrate variablegeneration through pooling mechanisms with neighboring balancing areas, assumingadequate transmission capacity.

Clearly, significant changes to gas and electricity markets and operations can help the energyindustry adapt to the twin drivers of shale gas and renewable energy. Many of the changesneeded in the electricity market have implications for both natural gas and renewable energygenerators along with other electric power stakeholders: The drive to more accurately valueflexibility across electricity institutions will directly benefit natural gas generators, whilemovements to co-optimize gas and electricity markets will have operational impacts on

renewable energy generators. Therefore, proactive engagement among the gas and renewableenergy industries and other electric power stakeholders to collaboratively resolve the diverse setof issues described above can enable the efficient technical, economic, and environmentalutilization of both natural gas and renewable energy in the near, medium, and long term.

3.4 Concluding RemarksNatural gas and renewable energy technologies offer very different and complementary attributesto consider within a portfolio and integrated systems approaches. These complementarities spanthe economic, technical, environmental, and institutional. The long-term evolution and structureof the electricity sector depends on the multilayered and compounded uncertainties presentwithin the range of possible industry developments and energy pathways. Further understanding

and quantitative analysis of the ability of a diverse electricity portfolio to maximize the benefitsand minimize the risks of each portfolio option can help inform stakeholder decisions and allowthe development of a solid foundation from which to handle uncertain futures.

The dramatic rise of shale gas and growing experience with renewable energy integration haveled to deep and still-evolving changes to market structures, physical systems, business practices,and regulatory policies. Both natural gas and renewable energy may play important future rolesin the electric power sector. In this critical period of industry adaptation to new energyparadigms, active engagement and partnership between the natural gas and renewable energysectors can lead to efficient well-designed electricity markets better situated to achieving thelong-term energy goals of energy security and climate change mitigation.

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4 U.S. Transportation SectorRenewable and natural gas fuels havesignificant potential to reduce petroleum dependence andemissions in the transportation sector.aaYet, to date, they have had limited market penetration.The following section seeks to illuminate various alternative transportation fuel pathways, andserve as a primer for discussion on transportation energy futures.

4.1 Petroleum Lock-InHistorically, petroleum products in the form of motor gasoline and distillate fuel oil (diesel) havedominated the U.S. transportation sector. Table 2 shows fuel usage by select on-roadtransportation modes for the year 2010. Petroleum products made up approximately 92% ofsector-wide energy usage in 2010 and dominated all modes of ground transportation consideredin this report.101

Table 2. 2010 U.S. Transportation Sector On-Road Fuel Usage (Energy Basis) by Mode

Petroleum Non-Petroleum

Share ofTotalSectorEnergyUse

Gasolinebb DieselPetroleumTotalcc

ElectricityNaturalGas

BlendedEthanoldd

BiodieseleeNon-PetroleumTotal

All Uses 100%a 57.0% 20.1% 92.3%b 0.1% 2.5%c 4.3% 0.9% 7.7%Light-DutyVehicles

58.2% 92.5% 0.3% 92.9% 0.002% 0.1% 7.0% 0.01% 7.1%

CommercialLightTrucks

2.0% 56.8% 37.4% 94.2% 0.0% 0.0% 4.3% 1.5% 5.8%

FreightTrucks

17.5% 6.8% 88.5% 95.7% 0.0% 0.2% 0.5% 3.6% 4.3%

Buses (alltypes)

0.9% 8.9% 83.5% 92.5% 0.0% 3.4% 0.7% 3.4% 7.5%aOther transportation uses such as rail, aviation, shipping, and military use are not shown.b This percentage also includes jet fuel, residential fuel oil, aviation gasoline, liquefied petroleum gases, andlubricants.cOnly 0.1% is from compressed or liquefied natural gas for transportation fuel, with the remaining 2.4% used forpipeline fuel natural gas.

The oil industry has evolved to serve the vast needs of the United States and the world and hasgenerally demonstrated the ability to meet market demand and respond to price signals. Thequestion remains, however, what will the cost of oil be? Dependence on petroleum has seriousimplications for economic growth, energy security, climate change, and as a result, foreignpolicy. In the context of increasingly globalizing energy markets, U.S. energy security can beenhanced by minimizing exposure to fuel price volatility and reducing risk of abrupt supply

aaTransportation accounts for 71% of U.S. petroleum use and 33% of GHG emissions.bbAssumes 95% of all gallons of gasoline consumed in the United States are blended with ethanol at an E10 (10%by volume) level. Assumes energy density of pure gasoline is 114,000 Btu/gal, and energy density of pure ethanol is81,800 Btu/gal (2012 Ethanol Industry Outlook.Renewable Fuels Association, 2012. Accessed August 30, 2012:http://ethanolrfa.3c dn.net/d4ad995ffb7ae8fbfe_1vm62ypzd.pdf).ccIncludes liquefied petroleum gases, not shown in the table.ddAssumes ethanol is blended with 95% of consumed motor gasoline gallons at an E10 level. Includes EIAestimates of E85 usage as well.eeAssuming 2 billion gallons of pure biodiesel was produced with an energy density of 118,300 Btu/gallon.

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disruptions. This can be accomplished by fostering diversity among which fuel types are able tobe utilized, and where they are sourced from. While domestic shale oil production has increasedin recent years to provide an added diversity, the capability of the transportation sector to moreflexibly utilize alternative sources of fuel would provide another type of hedge against volatility.Increasing penetrations of biofuels and plug-in electric vehicles will likely contribute to

accomplishing this. Abundant low-cost natural gas also presents opportunities to do so.

4.2 Alternative Transportation OptionsThis section will review the following alternative transportation options:

Ethanol

Alternative blended fuels

Drop-in biofuels

Plug-in electric and plug-in hybrid electric vehicles

Hydrogen-fueled vehicles Natural gas vehicles.

4.2.1 Ethanol

Among renewable fuels, corn starch ethanol has had the highest penetration in the transportationsector, due to blending tax credits, import tariffs, and the Renewable Fuel Standard (RFS) (seeSection 4.3.2). More than 95% of the 134 billion gallons of gasoline consumed in the UnitedStates in 2011 were blended with ethanol, typically at the E10 (10% ethanol) level. ff

,102E10 canbe used with existing vehicle engines and gasoline distribution infrastructure, and certainvehicles can safely accommodate higher blends such as E15. Because E10 and E15 blends arecurrently upper bounds for most vehicles, there is a limited amount of market penetration ethanol

can have without changes to fleet mix and distribution infrastructure. The 8 million flex-fuelvehicles in the United States can operate on gasoline with blends of up to 85% ethanol (E85),103though infrastructure to distribute blends above E10 is limited.104In general, pro-ethanol policiesface controversy, with critics saying subsidies are too costly, unfair, or unnecessaryggandsupporters claiming improved energy security, lower greenhouse gas (GHG) emissions, andincreased rural incomes and employment.105

Natural gas is a common input to both corn and ethanol production processes and, as a result,their prices depend in part on the price of natural gas. Corn is typically grown using fertilizer,and natural gas is a key feedstock to producing fertilizer; in fact, it accounts for up to 90% oftotal fertilizer production costs.106It is often used to produce heat for a number of process steps

necessary to convert corn to ethanol.

Cellulosic ethanol can be derived from a range of abundant biomass resources, mitigating manyof the potential macroeconomic and environmental consequences associated with corn ethanol.

ffDue to its lower energy density, ethanol-blended gasoline results in lower fuel economy.ggSome have argued that the ethanol industry would have been profitable far earlier than 2011 withoutsubsidization, some claiming as early as 2006 (Hurt, C; Tyner, W.; Doering, O.Economics of Ethanol. PurdueUniversity, 2006. Accessed August 30, 2012).

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Its production is c